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Rates of Return on Direct Investment August 1992 survey of current business 79 Rates of Return on Direct Investment By J. Steven Landefeld, Ann M. Lawson, and Douglas B. Weinberg Paul W. Farello, his article updates the alternative meas- usdia. This price adjustment is larger for usdia Ilona C. T ures prepared by the Bureau of Economic because most usdia occurred in the 1960's and Greenberg, and Glenn Farello of Analysis (bea) of the rates of return on foreign 1970's and thus tends to be ªolderº than fdius, the Balance of direct investment in the United States (fdius) most of which occurred in the 1980's. Payments Division and on U.S. direct investment abroad (usdia). It For usdia, the rates of return at market value and Steve B. Bezirganian and compares these rates of return with those on all- and at current cost are similar, on average, to the Arnold Gilbert of U.S.-business investment and discusses possible rates of return for all U.S. businesses. However, the International explanations for the relatively low rates of return for fdius, the rates of return at market value and Investment on fdius. Division assisted in at current cost are considerably below the rates providing data and Last year, bea introduced two alternative meas- of return for all U.S. businesses. (The historical- performing ures of the rate of return on direct investment cost rates of return for fdius are also quite low.) methodological that were based on bea estimates of the direct research for this The remainder of this article examines the ques- article. investment positions valued at current-period tion of why the rates of return on fdius are so prices: The return on direct investment positions low relative to the rates of return on domestic at market value, which is a measure of Wnancial investments.3 returns to direct investment, and the return on direct investment positions valued at current cost, 3. For other recent studies on fdius and the low rates of return on fdius, which is a measure of economic returns on di- see Harry Grubert, Timothy Goodspeed, and Debrah Swenson, ªExplaining 1 the Low Taxable Income of Foreign-Controlled Companies in the United rect investment from current operations. These States,º unpublished, contact author, Harry Grubert, U.S. Treasury) Novem- ber 1991; Edward M. Graham and Paul R. Krugman, Foreign Direct Investment alternative measures overcome a major limitation in the United States, 2d edition (Washington, dc: Institute for International of estimates of rates of return based on historical Economics, 1991); and ªReview of Internal Revenue Service Statistics on Foreign Controlled Domestic Corporations 1983 through 1988,º prepared by costsÐthe noncomparability of investments that kpmg Peat Marwick for the Organization for International Investment, July diVer considerably in age and therefore in priceÐ 1992. by presenting estimates on a consistent valuation basis. Table 1.ÐAlternative Measures of the Rate of Return Table 1 shows rates of return for usdia and for U.S. Direct Investment Abroad, Foreign Direct fdius based on market value and on current cost Investment in the United States, and All U.S. Businesses compared with a market rate of return for all [Percent] U.S. businesses; it also shows rates of return for Returns based Returns based Returns based on 2 on historical on current cost market value usdia and fdius based on historical costs. For cost both usdia and fdius, the rates of return at All U.S. current-period prices are lower, on average, than USDIA FDIUS USDIA FDIUS busi- USDIA FDIUS ness- the rates of return at historical costs. However, es 1 the diVerences are much larger for usdia than 1982 ........................... 11.4 2.7 6.0 1.2 n.a. n.a. 11.0 for fdius because the adjustment needed to re- 1983 ........................... 12.9 3.9 7.0 2.3 11.4 4.0 9.9 1984 ........................... 14.4 6.3 8.3 4.4 11.6 5.7 11.1 state direct investment positions from historical 1985 ........................... 12.6 4.3 7.9 3.3 9.1 3.2 8.7 1986 ........................... 12.2 3.7 7.6 2.8 7.2 2.2 7.2 costs to current-period prices is much larger for 1987 ........................... 13.4 3.6 8.3 2.6 7.7 2.5 8.1 1988 ........................... 15.5 4.4 10.0 3.4 8.4 3.9 9.0 1989 ........................... 15.2 2.2 10.2 1.6 7.9 2.2 7.6 1. For a discussion of the various measures, see ªAlternative Measures of 1990 ........................... 13.8 .4 9.4 .2 7.6 −.3 7.7 the Rate of Return on Direct Investment,º Survey of Current Business 71 1991 ........................... 11.2 −.7 7.7 −.8 6.9 −.2 6.0 (August 1991): 44±45. For a discussion of the estimates of direct investment Average, 1983±91 ..... 13.5 3.1 8.5 2.2 8.7 2.6 8.4 at market value and current cost, see ªThe International Investment Position of the United States in 1991,º Survey 72 (June 1992): 46±59. For a discussion n.a. Not available. of the concepts and estimating procedures underlying the current-period 1. This measure is a weighted average of the after-tax earnings per dollar of stock for Standard and Poor's Composite 500 companies and the average yield on corporate bond estimates of direct investment, see ªValuation of the U.S. Net International holdings rated AAA by Moody's Investors Service. The returns on debt and equity are Investment Position,º Survey 71 (May 1991): 40±49. weighted by the ratio of debt to equities at market value for nonfinancial corporate businesses published by the Board of Governors of the Federal Reserve System,Balance Sheets for the 2. The data are limited to the period from 1982 or 1983 to 1991 because the U.S. Economy, 1960±91, (Washington, DC: March 1992). complete information on equity Xows and equity positions that is required USDIA U.S. direct investment abroad for the market-value measure is unavailable for earlier years. FDIUS Foreign direct investment in the United States 80 August 1992 survey of current business • Returns on fdius erable portion of this new fdius consisted of acquisitions of Wnancially distressed U.S. compa- In examining rates of return on fdius,itisim- nies that foreign companies presumably hoped to portant to note that a multinational company restructure and restore to Wnancial health. tries to maximize its total proWts around the Long-term factors associated with the goal of world in deciding where to invest, where to pro- maximizing proWts on a global basis rather than duce, and where to realize its income. As a result, on an individual-country basis also may have a multinational company structures its opera- held down the rates of return on fdius. These tions, costs, and product pricing across countries factors included the following: Economies of to maximize its global proWts rather than to max- scale and the advantages of vertical integration, imize proWts on an individual investment or even diVerences between countries in the treatment on all of its investments in a single country. It of taxes, and avoidance of tariVs and nontariV may accept a below-average proWt to gain ac- barriers. cess to the large U.S. market or to scarce raw materials. Alternatively, it may accept low re- The analysis that follows covers the rates of re- turns on some parts of its operations to take turn on fdius for 10 of the 11 countries that were the largest direct investors in the United States advantage of economies of scale and technolog- 5 ical eYciencies in other parts of its operations. during the last decade. In 1991, these 10 coun- In addition to these types of operationalÐor tries accounted for over 90 percent of cumulative industrial organizationÐfactors, multinationals fdius, and the top 5 accounted for over 75 per- also take into account a number of other factors, cent (table 2). It should be noted that underlying such as diVerences across countries in the cost economic conditions and motivations for direct and availability of capital, in expected returns on investment vary markedly among these countries, investment, in the tax treatment of income, and and it is diYcult to generalize about the fac- in tariVs and nontariV barriers.4 tors leading to low rates of return on their direct The low rates of return on fdius appear to re- investments. Xect certain long-term factors associated with the operations of multinational companies and the eVects of a number of transitional factors that 5. Although the Netherlands Antilles' fdius position ranks eighth among led to a surge in fdius in the 1980's. In the all countries, it is excluded from the analysis because of the unique nature of its inward investment, which resulted from its activity as an oVshore Wnancial 1980's, current-account surpluses in Japan and center (oVshore Wnancial centers were created to avoid certain interest-rate several other countries generated excess funds controls, bank lending restrictions and reserve requirements, and other regu- latory constraints). Additionally, it had a favorable tax treaty with the United available for investment. Funds were attracted States that oVered an exemption from the withholding tax on certain interest to the United States by average yields on U.S. payments from U.S. aYliates to their Antillean parents. Consequently, for- eign corporations made large investments in the United States through their investments that were higher than those on Antillean aYliates rather than investing directly in the United States. home-country investments; this spread allowed However, over the past decade, the Netherlands Antilles' share of total fdius has declined substantially.
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